The leveraged buyout, the archetypal takeover deal of the 1980s, has become the most-sought deal for lenders at the dawn of the 2000s.
New statistics from Portfolio Management Data LLC of New York help to explain why. They show that pricing for loans to help finance such buyouts remained at record highs during the fourth quarter, when loans as a percentage of LBO financing reached all-time highs.
Some $30.2 billion of bank loans supplied 58% of the financing for the $52.5 billion of leveraged buyouts completed last year. More important, 74% of those loans - $22.5 billion worth - were actually drawn, or funded, by the borrowers.
Perhaps most important for lenders, the range of returns on those loans was the London interbank offered rate plus 200 to 400 basis points - price levels that easily fell into the market's definition of "highly leveraged" lending.
"The cost of financing LBOs has gone through the roof since September 1998," said Babek Varzandeh, a loan analyst at Portfolio Management Data. "The volume is there because these guys have done so much fundraising."
But bankers also said there is more to the rise in pricing and volume than these numbers indicate. Firstly, loans have come back into vogue as the financing of choice for LBO sponsors. Secondly, institutional investors are continuing to drive the market by demanding better pricing. John F. Yang, a managing director of leveraged finance for Merrill Lynch & Co., said that after the credit crunch of the early 1990s, LBO sponsors shied away from bank loans in favor of junk bonds. Since the bond crisis in late 1998, LBO sponsors have turned to banks to finance their deals and have found the terms and financing costs more attractive.
"It's run in cycles," Mr. Yang said. During the credit crunch, sponsors said, "I'm never going to be captive to the banks again.' Today, the fact is people are embracing syndicated loans in a big way, and loans have become attractive compared to fixed-rate bonds."
As a result, the institutions investing in loans have been able to be more choosy, said Eric Swanson, co-head of senior debt origination for Donaldson Lufkin & Jenrette in Los Angeles.
In the last three months of 1999, DLJ arranged two loan packages for LBOs that had different fates: a $475 million loan package for Madison Dearborn Partners buyout of Outsourcing Solutions that was oversubscribed by investors and syndicated quickly in November, and a $161 million loan package to Weekly Reader/JLC. That loan was slow in syndication, despite offering the same pricing - Libor plus 400 basis points - to institutional investors.
The difference, Mr. Swanson said, was the size of the companies. Outsourcing Solutions has more than twice the revenues of Weekly Reader. "Investors naturally like large companies because they seem less susceptible to downturns," Mr. Swanson said. "And I think it's a reasonable assumption."
Though there's agreement about the changing face of the LBO loan market, opinions diverge about how that market will serve banks in 2000. Mr. Yang said he believes pricing will continue to hold at current levels, arguing that prices have risen from an unusually competitive market two years ago.
Mr. Swanson disagreed, citing supply and demand adding that pricing "is ready to start coming down." He said that with the new year, banks and institutional investors have new budgets and fresh cash to invest.
Though "there's not a lot of data that shows a break in pricing," Mr. Swanson said, "what drove the pricing up is what happened with the institutional market," so those investors will be willing to accept smaller returns in order to put their money to work.